The DJIA made it back above the May/April low level; the S&P 500 Index bounced off a similar level and its 200 day moving average; the NASDAQ Composite managed to retake its 50 day moving average; and the Russell 2000 held a long term support/ resistance level and its 200 day moving average. Tuesday was a good day with several key reversals in representative stocks across different sectors and improved volume. The levels I mentioned on the indices remain important going forward, in fact after yesterday’s moves, they have increased in technical significance, and the ability to begin building a base above them could have longer term implications for the market.
The short rally earlier in the month was accompanied by very weak volume. Today’s move, while at this point a one day event, saw a jump in volume 10% above the 50 day moving average of volume.
We’re all familiar with the morningstar candle pattern. It is a three day bullish reversal pattern formed by a large dark down candle, followed by a narrow opening and closing range “doji” candle, and completed by a large white up candle. It reflects a transition from bearishness to bullishness. This pattern has formed on the daily charts of several stocks that have been particularly problematic recently: the iShares Nasdaq Biotechnology (IBB) ETF, the Market Vectors Semiconductor ETF (SMH), Exxon Mobil (XOM), Caterpillar (CAT), Dow Chemical (DOW), and Wal-Mart Stores (WMT). The morningstar is one of the more reliable technical patterns and is often seen at important bottoms, but like any candle formation or technical pattern it requires confirmation.
The McClellan Oscillator measures breath by subtracting the 39-day exponential moving average of NYSE net advances from the 19-day exponential moving average of NYSE net advances. Over the last five months the indicator has touched or nearly touched the -60 level, and each time it has been an oversold reading that was followed by a rally in the stock index. It is very close to that level once again and this morning we are seeing strength in the futures.
The utilities were the outperforming sector in today’s decidedly dismal market. The Utilities Select Sector SPDR (XLU) was up 1.2% and formed what could be a morning star reversal pattern on its daily chart. This three day pattern consists of a large dark candle, followed by a small opening and closing range “doji” candle, and completed by a large white candle. It represents a transition from bearishness to bullishness, and is often seen at important bottoms. The relative strength index is attempting to cross above its centerline reflecting positive price momentum and the daily MacD which is overlaid on a weekly histogram, is attempting to move above its centerline on both timeframes. Chaikin money flow has been improving since the end of June and today is above its centerline, indicating greater buying than selling pressure. Today’s close was just below the 50 day moving average and follow-through strength would be another technical positive and confirm the morningstar pattern.
It was not a good week for stocks with the S&P 500 index down 2.2% and the DJIA pulling back 2.8%, the NASDAQ Composite off by 2.3%, and the greatest damage being done in the diverging Russell 2000 which dropped 3.2%. Bearish engulfing candles formed on the weekly S&P, DOW and Russell charts, and a large “dark cloud cover” candle can be seen on the NAZ chart.
We remain in a period of consolidation in these major averages, and we have seen bullish reversals immediately follow large dark down weeks, but channel and key average support are being severely tested. The decline earlier in the week was on low volume but that changed on Friday, with it moving back above the 50 day moving average of volume, and accumulation/distribution continuing its downward trajectory and moving below its 21 period signal line.
What all this means simply is that the action in these areas has to be monitored very carefully, with the advantage being that the key levels of support are clearly defined.
The action on the major index charts yesterday was significant with the S&P 500 index and the DJIA pulling back to their 200 day moving averages, the NASDAQ Composite dropping below its June high, and the Russell 2000 forming a large bearish engulfing candle below its 50 day moving average. The weekly close is always important and we will check that out over the weekend. As I mentioned yesterday, on the weekly timeframe the S&P is in a horizontal channel consolidation and if support is tested, the assumption is that it will hold and the index will bounce, at some point breaking through channel resistance and resuming the bullish trend. Of course, this is an assumption based on classic technical patterns and past performance, and it requires confirmation, but also the ability to readjust along with the price action and the data.
If you step back from the day-to-day perturbations of the broader market and look to the weekly timeframe, the picture often becomes less turbulent and more placid. What we have been seeing for most of this year is a classic horizontal consolidation phase after a long term trending period. At this point it’s that simple. Consolidations are healthy pauses that very often allow the market to reset and eventually resume the longer term move. There have been recent signals that we may have neared the top of the channel (I have written about them here), but these cannot be extrapolated beyond the possibility we are headed towards the bottom of the range. At that point, if conditions further deteriorate then we will have to reevaluate the technical strength of the market.
The number of stocks in the S&P 500 that are above their 50 day moving average has been declining since the beginning of the year, in clear divergence to the index.
Breadth indications have been problematic during the most recent phase of this rally. This has been noted many times on these pages and my most recent observation was yesterday before the open. But at this point, the movement on the S&P chart looks like a simple horizontal channel consolidation after a long rally period. This is normal and healthy action with the assumption being that after this reset period the index will resume trading in the direction of the primary trend.
That said, the levels of support that define the channel pattern should be watched carefully, as well as action around the key moving averages. Don’t overreact to short term perturbations in the market, be patient, and follow the direction of the charts.
This chart of the NASDAQ Composite is overlaid with a cumulative advance/decline line, and the individual NSADAQ advances and declines are at the bottom with five day moving averages. The divergence in the number advancing versus declining shares can be seen as the index makes new highs. This of course could correct, it is a short term divergence, but it could also be a signal that the rally in the tech stocks is nearing a conclusion.